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EQUITY VALUATION and ANALYSIS EVA, Take over - Coggle Diagram
EQUITY VALUATION and ANALYSIS
EVA
Valuation
Value
Type
Book value
Total Asset - Total liabilities
aka Net asset value
Original cost - depreciation, amortization or impairment cost
Going concern value
amount that could be obtained by selling the business as a whole, assuming that it will continue to operate and generate cash flows in the future
Liquidation
amount that could be realized by selling the assets of a business in a forced or distressed situation
Intrinsic value
true value of an asset
Based on
Fundamental characteristic
Future earning/growth potential
Market value
Fair value
the price at which an asset would change hands between a willing buyer
and a willing seller and neither buyer or seller are under any compulsion to buy or sell.
Replacement value
Special value
Additional value place on an asset, unique to an individual investor
Analysis
Model
FREE CASH FLOW
FCFF
VF = FCFF / (1+WACC)^t
=E + NCC -WCInv - FCInv + Other NCL + Interest expense (1-T)
= FCFE - Net borrowing + Interest (1-T)
Interest(1-T) = INTERE
Distribution to debt holder and share holer
(B+D) of t-1 + Earning of t - (B+D) of t
FCFE
= All Cash inflow - all cash outflow
Definition
= E + NCC -WCInv - FCInv+ Net borrowing + Other NCL
NCC = NON CASH CHARGE
WCInv =
CHANGE
IN NET CURRENT ASSET
=current assets - current liabilitie -
interest bearing liabilities
s
FCInv = FIXED CAPITAL INVESTMENT
= change in non current asset between 2 period + depreciation of the period
Net Borrowing
Change in interest-bearing debt (BOTH CURRENT AND NON CURRENT)
Other NCL = CHANGE to the remaining NON CURRENT LIABILITIES AND MINORITIES INTEREST
E = Net income
= Distribution to share holder= duality of FCFE
= Equity of last period (t-1) + earning of current t - Equity of current t
Value of firm
Value of Equity
=VF -VD
Note: VD = value of debt-> difficult to find => use book value of debt
COST OF EQUITY
CAPM
Beta
covariance between stock return vs market return
Risk free rate - Rf
Fed vs state bond
ST vs LT bond
Equity risk premium
Market risk - Risk free rate
Rm-Rf
Rm
Share price index vs Accumulation Index
2 more items...
process of estimate of an asset value
base on
perceived future investment return
comparison with similar assets
Role
Present value of CF
Perpeptuity
Anuity
With growth
2 stage growth
EARNING VS CAPITAL
EPS1 = ROE1 x BVPS1
BVPS = Total equity / number of share
PEG
g=b x ROE
PE/g
EPS(BUYBACK)
(E(future) - e') / (n-m)
ROE
Net profit / Equity
divided by the number of share
EPS / BVPS
(Price/ Book value) / (Price/Earning)
PB/PE
Price/ Earning per share
1 more item...
FORECASTING
? SALE IS DEPENDENT ON THE ECONOMY
DISCUSS THE FACTOR THAT AFFECT THE SALE
ADVANCED CORPORATE FINANCE
MM1
Assumptions
MM1 With Tax
Relative Advantage Formula RAF
RAF< 1 => Debt advantage
RAF >1 Equity advantage
RAF = 1 - Indifference between debt vs equity
VL = VU + PV (interest tax shield)
Permanent Debt
Temporary debt
Tax shield = Tc(RD x D)
PV (Tax shiled) = [Tc x (RD x D)] / RD
=
Tc x D
VU = (1-Tc)X/RA
VL = (1-Tc)X/RA + Tc(RD x D)/ RD
WACC
Pretax
Tax
FCFF
Value of firm (VF) = FCFF/ (WACC-g)
ALSO SEE ABOVE FCFF
No tax
VL = VU
Tc= Corporate tax rate
D= Debt level
RD = interest rate
RA = rate of return for Unleverage firm
X =CF
Debt + equity
Leverage
equity only
Unleverage
Lease
Definition
type
Operating lease
Short-term, cancellable lease
Financial lease
– Rental lease ( Full service)
– Net lease
– Direct lease
– Sale and lease-back
– Leveraged lease
Long term, noncanelable
Why
Sensible reason
– Short-term leases are convenient
– Cancellation options are valuable
– Maintenance is provided
– Standardization leads to low costs
– Tax shields can be used
– Leasing and financial distress
– Sidestepping the limitation on debt interest
Dubious reason
Avoid capital expenditure controls
Preserves capital
Lessee: who lease
NPV
+Cost of asset
-PV(payment)
+PV (Tax saving/cost on lease payment)
-PV (tax saving on depreciation)
-PV(after tax residual value)
No cost (as did purchase the asset)
pay the lease
Tax shield on lease
No deprciation
positive for both
Taxation
Lessor tax rate > Lessee tax rate
=> higher tax saving cost
=> Charge lower borrowing rate
=> lessee payment lower
Cost of capital
COC Lessor < lessee
ownership transfer to lessee
=>the financial risk of the lessor is not that high and can borrow at a lower rate.
TRANSACTION COST
Lessor: who own the asset
NPV
-Cost of asset
+PV(payment)
-PV (Tax saving/cost on lease payment)
+PV (tax saving on depreciation)
+PV(after tax residual value)
SALE AND LEASE BACK
Reason
Raising funds
Diversifying funding sources
Improve efficiency
Enhancing occupational flexibility
Disposing of low-yield assets
Convertible debt
Bond <-> Stock
Right to convert
embbedded call
callable and putable
Conversion ratio
The number of shares the bond holder gets when converting one bond into shares.
Conversion price
Implied purchase price in the bond currency of the convertible upon conversion is face value /
conversion ratio
Premium to parity
Bond floor
Valuation
Biomial
Corportare Governance
Agency conflict
Board of directors
Board independence
role
Size
Larger board size , lower performance
explanation
Larger number => harder dicision making
Larger group => easier for CEO to control
Ownership of equity
0-5%
5-25%
higher 25%
Legislation
defines fiduciary duties for managers
Important legislation
SOX 2002
Prohibits personal loans to directors and executive office
Restriction on stocks sale during retirement plan blackout periods
Audit
Dodd-Frank 2010
Executive Remuneration
DIVIDEND POLICIES
Free cash flow
Retain
Inv in new Project
Increase Cash Reserves
Pay Out
Pay Dividends
DIVIDEND
Likely to increase or NOT CHANGE in dollar Dividend
Repurchase Share
Increase in trend
Increase value of the remaining share (less share outstanding)
Possible reason
Flexibility
Buybacks offer more flexibility than dividends. Companies can adjust buybacks based on their financial situation.
Tax Efficience
Management compensation:
Some managers receive stock options or other compensation tied to the stock price. Buybacks can increase the stock price, potentially benefiting these managers.
LINTNER'S FACT
Companies aim for a consistent dividend payout ratio (percent of profit paid as dividends) in the long term.
Managers focus on increasing or decreasing dividends, not necessarily the exact amount paid.
Dividend changes reflect long-term earning trends, not short-term fluctuations.
Managers avoid cutting dividends if they think it might need to be raised again later.
Companies may also buy back their own stock (rep repurchase) if they have extra cash or want to adjust their capital structure.
MODEL
Div1 - Div0 = adjustment rate x [(target ratio x EPS 1)- Div0]
Target Dividend (NOT actual)
Div1 = target payout ratio x EPS1
Target Dividend Change
Div1 - Div0 = target ratio x (EPS1 - Div0)
THEORY
MM: Dividends DO NOT affect value
Dividend are bad
: taxed more than capital gain
topic 6 pp 22-30
Excess cash hypothesis
Argument
excess cash (for dividend) = no investment => no growth
Counter
Excess cash can be temporary
Consider stock by back
Dividend are good
Clientele Effect: Some investors prefer companies that pay regular dividends, so attracting these investors by offering dividends can increase the company's value.
Signaling: Increasing dividends can be seen as a positive sign by the market, indicating strong financial health and potentially leading to a higher stock price.
Wealth Transfer: Paying dividends can be a way to transfer wealth from bondholders (who receive interest payments) to stockholders (who receive dividends).
Agency Costs: Dividends can act as a control mechanism on managers. By forcing them to pay out some cash, it reduces the risk of them using the money for unnecessary investments or empire building.
INTERNAL CAPITAL MARKET
m&a
Synergy
Identify
the concept that the combined value and performance of two companies will be greater than the sum of the separate individual parts.
1 + 1 >2
Gain/Loss
Total gain /Target gain / Bidder gain
Efficency
All gain
Overpay
Total gain =0
Target = + gain
Bidder = - gain
Agency problems or mistake
Total gains = - gain
Target = + gain
Bidder = - gain
Target always gains as unable to sell with lower price than the market price
Merger
Type and motives
Horizontal
2 firms with SAME LINE of business
increase market power/market share
Vertical
firms at DIFFERENT STAGE of production
Efficiency in operation
cost saving
May also negative affect compatitor (by constrain/limit their supply
Conglomerate
Firms with UNRELATED LINES of business
Diversification
Sensitive Motive in general
Economic of scale
Large firm => reduce cost by unit
Cost saving
Efficiency in operation
Negative impact competitor
Complementary resource
Additional resource from merger (Copy right, chain of supply etc)
Surplus Fund
Extra positive NPV project if has extra fund (wand have limit project available)
Big companies with limit potential to growth or extra project
Eliminate in efficiencies
Tax benefit
Obtain company with loss to have tax deduction
Dubious Reason
Diversification
Related to empire building
Related to manager entrenchment
Reduce risk
Increase EPS
Buy high PE firm + sell low PE firm
Free rider problem
Target firm get increase in price due to better management
If merge => share price will increase ++ (final price)
=> Offer price > = Current price
1 more item...
Potential solution: Toehold
1 more item...
internal capital market
Cash (required for project) is funded internally
STEIN'S 1997
assumptionS
Credit constrained
Not all +NPV can be financed/go to market when needed
Managers are self interest
Implication
Winner Picking
Keep good division, sell bad division
Not always happened
Managers TREAT all division EQUALLY
Empire building
Diversification allow managers to retain prestige and power
Entrenchment
Managers cares about their position => take less risk => move diversification
Cost
Eliminate/discontinue a division could incurrred higher cost than continue
Determination of winning/losing
determination of winning and losing division is complex
Could also be subjective
Advantage
Protect firm secret (technology, copy right etc)
Protect firm asset (compared to bond/ loan)
MAY save cost from loan or equity
IPO
Venture capital Vs Debt
sometime, lenders do not understand or trust new venture
Lender require collareral
some doesnt exist, some difficult to get (as new venture)
Debt may inhibit growth as firm need to repay loans rather than invest in growth
Interest is obligation, dividen is not
Underwriter
Investment bank that manages security issuance and design its structure
Primary and secondary offering
Old share holder forbid to share in secondary market for a certain time
Spread
difference between public offer price and price paid by under writer
Type of offering
Firm commitment
Underwrite guarantee to sell all the stock at offer price
Best effort
Underwriter does not guarantee to sell all the stock, sell the stock for the best possible price
Auction IPO
Reason
Raising capital
Exposing to public information
use share a collateral for loan
Establish market price or value for firm
Exposing to bigger market
Create public share for future M&A
Allow venture capital to cash out
Cost
Direct cost
Financial cost, including accounting, legal, printing
Indirect cost
Time
Discussion
Negotiation
Preparing
Waiting
Disclosure of information
Agency cost
UNDERPRICING
Reason
Rock model
IPO are underpriced because informed investors have better info and only buy cheap deals. To attract uninformed investors who rely on price as a value signal, companies lower the offering price
Market feedback
Lower prices entice informed investors to reveal how much they really value the IPO, helping set a fair price.
Bandwagon effect
Jump on the bandwagon: Lower prices create a sense of hotness, attracting more investors who fear missing out.
Lawsuit avoidance
Underwriting can be risky, but underpricing might be done to avoid lawsuits in some places, even if not always effective.
Signaling Hypothesis
a successful IPO (due to underpricing) creates goodwill, allowing the company to raise money at higher prices later. There's not much evidence to support this though.
Compensation for underwriter
Underwriters take a risk if they can't sell all the shares. Lower prices can make them easier to sell, reducing the underwriter's risk.
Compensation for owner
Underpricing can be seen as leaving money on the table for the company's owners. The initial price gain could have been captured by selling fewer shares, resulting in less dilution (ownership stake decrease) for the owners.
MANAGER MAY NOT BE BOTHER BECAUSE
Prospect Theory:
People tend to feel less excited about gains than they feel bad about losses. So, if the IPO price is higher than expected (even if it's underpriced compared to the true value), managers might be satisfied due to exceeding expectations (prospect theory).
Secondary Offering
: Companies often only sell a small portion of their shares in the IPO. This means they can raise additional capital later through a secondary offering, potentially at a higher price if the company performs well after going public
Attract media
underprice => significant price increase after IPO => Attract media => free marketing
Enhence Investment bank reputation as successful IPO
FINANCIAL STATEMENT ANALYSIS
Asset
Definition
Controlled by the Entity
Result of past event
Economic resource
Non current
yield benefit > 1 yr
Tangible
PPE
Intangible
Goodwill
Analysing
Depreciation and Amortisation
Impairment
Current
Cover ST liability
Expected to be sold, collected, or used within a year
CASH and CASH EQUIPVALENT
Definition
Cash
Equipvalence
RECEIVABLE
Acc Rec
No interest charge
Note Rec
Charged interest
Analysing
Authencity of Receivable
Collection risk
Determine competitors’ receivables as a percent of sales relative to the company under analysis
C ompared to your competitor
Examine customer concentration
How much/How many % that the customer is borrowing
Investigate the age pattern of receivables
overdue and for how long
Determine portion of receivables that is a renewal of prior receivables
Analyze adequacy of allowances for discounts, returns, and other credits
Securitization
Definition
With resource
Without resrouce
Prepaid Expense
INVENTORY
FIFO
Analysing
LIFO
AVERAGE
Investing activity
Intercorporate Investment
Company invest in another company
Purpose
Type
Debt securities
Held to Maturity
Trading
Available for sale
Lecture 4 slide 4
Equity securities
No influence
Below 20%
Trading or Available for sale
Significant influence
20-50%
Controlling interest
above 50% holding
Lecture 4 slide 5
Analyse
Objective
To separate operating performance from investing
(and financing) performance
To analyze accounting distortions from investment securities due to earning management and/or accounting rule
Method
Equity Method Accounting
Purchase Method
Goodwill
Lecture 4 page 14-15
RATIO
Liquidity ratio
Current ratio
Consideration
Profit/loss in INVENTORY
CA/CL
Improve
Cash based ratio
Cash to current asset
Cash to current lianbility'
Account Receivable liquidity measure
Account receivable Turnover
How often the firm collect its current receivable in recent year
Higher the btter
Net Sale on credit / Average account receivable
Day Sale in receivable
On average how many day the firm take to collect the receivable
Lower => better
Account receivable / (Sale/360)
Receivable Collection period
On average, how many day the firm will collect the payment of sale on credit
360/ Acc rec turn over
Inventory turn over
Days Sale inventory
Inventory / (COGS / 360)
360/ Inventory Turnover
Inventory Turn over
COGS / Average Inventory
Current liabilities
Days purchases in Acc Payable
Acc Payable / COGS
Acc Payable Turnover
ACID test ratio
Solvency
Long term
Capital structure
Equity vs debt financing
Ratio
Total debt/ Total Capital
Total debt / Equity Capital
LT debt / Equity Capital
ST Debt/ Total debt
Earning to fixed charged
Earning available for fixed charges / fixed charge
Time interest earn ratio
(Income + tax expense + interest expense) / interest expense
Profitability
ROI or ROIC
Income /Invested capital
Invested Capital
For main activities of a business
Planning
Goals and objectives of the business
Financing
Acquiring fund to execute plan
equity
debt
Investing
Buying and maintain asset for functioning
ppe
Intangible asset
Operating
execute plan
Take over
Synergy
Operation synergy
Economic of scale
Pricing down
Financial synergy
excess cash
Debt
Tax benefit
